Shareholder disputes are an unfortunate fact of life for many companies, particularly SMEs owned and managed by the same individuals. Internal conflict can be just as devastating to a company as litigation with external parties.
Sometimes, its impact can be even more severe. When shareholders cannot agree on key issues relating to the company’s management, its performance can be disrupted, its reputation tarnished, and, in the worst-case scenarios, the business can fail.
In this article, Liz Black, senior business dispute solicitor at Harper James, discusses the common reasons shareholder disputes occur and the legal options available to shareholders involved in a dispute.
Why do shareholder disputes occur?
Numerous issues can trigger a shareholder dispute, including:
Disagreement over the direction of the company
For a company to prosper, those at the helm need a shared vision of its commercial goals and must agree on a strategy to realise them. When the shareholders’ viewpoints diverge, problems often arise. Disagreement over the direction of a company is one of the most common causes of shareholder disputes.
Breach of a shareholder’s fiduciary duty
Generally speaking, a fiduciary duty is a duty of good faith and loyalty; a legal obligation to act in another party’s best interests. Whilst directors are under a fiduciary duty to put the company’s interests before their own, the same does not apply to shareholders who are, on the whole, entitled to act as they wish. However, in certain, albeit rare, circumstances, fiduciary obligations may exist between the shareholders of a small company. Where such a duty does exist, disputes can arise if an individual is deemed to be putting their own interests ahead of those of their fellow shareholders.
Differences in contribution or compensation
In small or family-owned companies, it is common for key people to act as both director and shareholder. It is crucial to strike a balance between remunerating the director-shareholders for their managerial role and providing a reasonable income to the non-managing shareholders by way of dividends. Disputes regularly arise when there is perceived unfairness over the level of the directors’ salaries, particularly if this leaves little in the pot to be distributed as dividends. Issues can also arise between the shareholders if their respective contributions are disparate, yet their income is the same.
Conflict of interest
Unlike directors who must act in the company’s best interests, shareholders are generally free to vote howsoever they wish. As a result, shareholders’ personal interests can conflict, and disputes can develop.
Disputes over the valuation of shares
Shares might need to be valued for several reasons, such as when a shareholder wishes to exit the business. Valuing shares in a public company is straightforward. The share price is listed daily, and a buyer pays accordingly. In private companies, however, the position is far more complex. Various valuation methods can be utilised, and fierce disputes often emerge over which is appropriate and whether any discounts should be applied. If there is no Shareholder’s Agreement, or the agreement is silent on valuation, a prolonged stalemate can ensue.
Minority shareholders’ interests not taken into account
Shareholder decisions are based on to the principle of majority rule, and a minority shareholder’s rights are somewhat limited. In companies where the majority shareholders are also directors, the minority has virtually no say over the management or direction of the company and has no access to the company’s financial information. Disgruntled minority shareholders have several options through which to seek recourse when their interests are not being taken into account, including bringing an unfair prejudice claim.
How can shareholder disputes impact the day to day running of a business?
Shareholder disputes can be disastrous for a company. Time, money and attention are diverted away from business operations towards addressing the issue, leading to a downturn in productivity and, ultimately, profitability. In some cases, a shareholder dispute can lead to the company being wound up.
Is there a Shareholder’s Agreement in place?
Ideally, the shareholders will have entered into a watertight Shareholder’s Agreement. The Agreement should address most issues that can lead to disputes, such as how deadlock is to be resolved and how shares should be valued. If a dispute does arise, the Agreement should contain a dispute resolution clause detailing the steps to be taken to address it.
How can I resolve a shareholder dispute?
The best way to resolve a shareholder dispute depends on the issue at hand. If a Shareholder’s Agreement is in place, any dispute resolution mechanism must be followed.
There are several methods through which a shareholder dispute can be addressed which do not require the Court’s involvement, including:
Proposing a general meeting
Any shareholder with at least 5 per cent of the voting rights can call a general meeting. At the meeting, the shareholders can discuss the issue and seek a mutually agreeable resolution. Alternatively, the issue can be put to a vote. This solution is quick and cheap but depends on the parties being amenable to potential compromise.
Direct negotiations between the parties sometimes lead to a workable compromise. The parties’ legal advisors can be present to keep things on track and encourage meaningful discussion. Negotiation is quick, cost-effective and often preserves the parties’ relationship. However, the parties’ positions are sometimes too deeply entrenched for any headway to be made, and negotiations prove fruitless.
Mediation is a form of alternative dispute resolution through which the shareholders seek to settle their dispute with the help of an impartial third party, the mediator. Mediation is quicker, cheaper and less stressful than litigation. It is commonly used to settle shareholder disputes, with excellent results. However, the mediator cannot force a settlement, so if the parties’ positions are too far apart, a resolution may be unlikely.
Arbitrations are heard by an independent third party, the arbitrator, whose decision is binding and enforceable. Arbitration is more flexible than litigation, employs simplified rules of evidence and allows the parties greater control. It is usually, but not always, cheaper than litigation. However, the flexibility of the procedure can lead to unpredictability and perceived unfairness, and the binding nature of the decision leaves little room for appeal.
Sometimes, the relationship between shareholders deteriorates to such an extent that they can no longer work together. In these cases, the parties can agree to a clean break whereby one shareholder’s shares are bought by the others.
What legal remedies are available to shareholders?
If the dispute cannot be resolved without recourse to litigation, a shareholder may invoke several legal remedies, depending on the circumstances. They include:
Unfair prejudice petition
Unfair prejudice petitions are a potent weapon for minority shareholders. They allow the shareholder to ask the Court to prevent the majority shareholder from acting in a way that negatively impacts their position or the value of their shares. If the claim succeeds, the Court can make a variety of orders, including share buyouts and corporate governance improvements.
Derivative claims relate to conduct that harms the company as opposed to individual shareholders. They usually stem from a director’s breach of fiduciary duty and can result in the Court making various orders, including injunctive relief and changes to how the company is governed.
Winding up petition
The most extreme remedy available to shareholders is to ask the Court to wind up the company. Since this remedy effectively brings about the business’s demise, the shareholder will need to present a compelling reason for requesting it.
Prevention is always better than cure in the context of shareholder disputes. By investing in a watertight Shareholder’s Agreement from the outset, shareholders can ensure that all their rights and responsibilities are clearly defined and understood and minimise the likelihood of a dispute. Any problem that does arise must be addressed swiftly and effectively to mitigate its impact and allow the directors and shareholders to concentrate their efforts on ensuring the company’s ongoing success.